Fed ready to take 'unconventional measures'

By Hibah Yousuf, staff reporterAugust 27, 2010: 12:43 PM ET

NEW YORK (CNNMoney.com) -- Federal Reserve chairman Ben Bernanke bluntly acknowledged that the U.S. economic recovery has lost considerable steam, but said the central bank has the necessary policy tools to support continued growth.

"The issue at this stage is not whether we have the tools to help support economic activity and guard against inflation," Bernanke said at the Fed annual symposium in Jackson Hole, Wyo. "We do."

Making his first public comments since the central bank announced it would buy additional long-term Treasurys to boost the recovery, Bernanke said that the pace of economic growth is "somewhat less vigorous" than expected, but remained optimistic for a pickup in 2011.

Bernanke reiterated that the Fed would reinvest in Treasurys to maintain the size of its balance sheet, and added that the bank is prepared to provide additional "unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly."

Earlier Friday, the government lowered its reading of second-quarter economic activity to an annualized growth rate of 1.6%, down sharply from the 2.4% previously estimated.

Bernanke said the Fed will continue to monitor developments in the economy and evaluate other options to try and reverse the slowing momentum.

He said the Fed could purchase additional longer-term securities beyond Treasurys, since that was an effective strategy earlier. But he warned there are risks that the move would increase concerns about the Fed's so-called exit strategy.

Bernanke said the central bank could also modify its "extended period" language to communicate that the Fed would hold rates low for a "longer period than is currently priced in markets."

He added that the Fed could decrease the interest rate it pays to banks that keeps their excess reserves at the central bank in order to give banks more incentive to increase lending. But Bernanke warned the effect of that move alone would be relatively small.

"Bernanke now appears willing to discuss all the central bank's options for introducing further policy stimulus, but doesn't seem entirely convinced that they would necessarily be effective," said economist Paul Ashworth of Capital Economics in a statement, adding that additional actions from the Fed shouldn't be expected any time soon.

But that could be because those measures aren't necessary yet, said Dean Croushore, chair of the economics department at the University of Richmond and a former economist the the Federal Reserve Bank of Philadelphia.

"Bernanke wanted to lay out the possibilities in case things get a lot worse, but at the same time, all the talk about a double-dip recession is overblown and based on a couple of noisy data points," said Croushore, who was a Fed economist for 14 years.

Bernanke said the central bank has not agreed on specific criteria that would prompt action, but Croushore said it would take at least a few months of consistently downbeat data, particularly in the job market, before the Fed would pull the trigger.

Bernanke also addressed the Fed's critics who argue that the central bank should increase its inflation goals, adding that there is "no support" for this option at the Fed because the risk of an "undesirable rise in inflation" seems low.

But Bernanke also rejected concerns about deflation, saying that risks are not "significant" now.

The initial comment about raising inflation goals spooked investors and sent stocks into a temporary decline, but markets later turned up as investors digested the remainder of Bernanke's comments.

"He quickly dismissed the proposal and confirmed that the Fed stands for low inflation," Croushore said. "He also proved that the Fed still has bullets and is in control, which has been helpful to markets."

But Croushore said that the economic outlook remains uncertain. So investors will remain on edge and focus on each incoming data point for more direction.

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